A note on One Way Sensitivity

Analysis
Emanuele Borgonovo
Department of Decision Sciences, Bocconi University
One way sensitivity analysis is a simple and intuitive method of per-
forming sensitivity analysis.
The basic intuition is as follows. We are interested in understanding
the behavior of the expected utility of each alternative, as a function of
a predetermined parameter.
To illustrate, let us consider the revised Book Browser example (see
Figure 1).
The decision tree corresponding to this problem is in Figure 2.
We have two alternatives, either to develop the new division or not to
develop it. Let us call the corresponding expected utilities U
D
and U
NotD
.
Then, suppose we wish to perform the sensitivity on the probability that
no competitor enters the market.
Our rst step is to denote this probability as a parameter (or vari-
able). We chose the symbol x. The second step is to assign a range to
this variable. Because it is a probability and nothing else is specied,
we assign [0; 1] as a variation range for x. The third step is to express
the expected utilities as a function of this variable. We have
U
D
(x) = 13 x + 3:4 (1 x) (1)
With a slight manipulation, we get
U
D
(x) = 9:6x + 3:4 (2)
Observe that if you set x = 0:3, you get U
D
(0:3) = 6:28.
Then, we need also to write U
ND
as a function of the probability of
no competitor entering. We have:
U
ND
(x) = 5 (3)
In this case, the expected utility is constant, because we receive a xed
payo of 5. Note that this is not always going to be the case.
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q Book Browser, Inc. is evaluating whether or not they
should commit to start a new division which
specializes in the web-based sale of rare books.
q They have already spent money in the investigation
of this opportunity, but they have to spend additional
2MUSD if they decide to enter the market.
q They believe that there is a 30% chance that no
competitors will enter the market.
q In that case, they expect to earn $15 milions
If one ore more competitors enter (which they
believe happens with P=0.70), BB expects to earn
5.4MUSD
q If BB does not enter the market, it can have sure
profits from other initiatives equal to 5MUSD
Figure 1: The revised Book Browser example as per our slides.
0.3
New Division
13
New Division 13 13
0 6.28 0.7
No New Division
3.4
1 3.4 3.4
6.28
No New Division
5
5 5
Figure 2: Decision tree for the revised Book Browser.
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The fourth step is to plot U
D
(x) and U
ND
(x) on the same graph.
We have the result in Figure .
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
0
2
4
6
8
10
12
14
x
y
U
D
(x), blue, and U
ND
(x), red, in a one-way sensitivity plot as a
function of the probability of a competitor entering (x).
The fth step is to obtain insights from the graph. In our case, we
obtain the following insights. First, we see that the expected utility of
developing the new division is increasing in x. Thus, the higher the
value we assign to the probability of no competitor entering, the higher
the expected utility. This insight is call sign of change or direction of
change.
We can then determine the value of the probability of no competitor
entering for which we are indierent between developing or not is the
point on the horizontal axes at which the expected utilities intercept
each other. This point is found by setting
U
D
(x) = U
ND
(x) (4)
which leads to the equation
9:6x + 3:4 = 5 (5)
whose solution is:
x =
5 3:4
9:6
=
1:6
9:6
=
1
6
= 0:166 67 (6)
Then, we can use this value to state the following.
We can then determine the robustness of our decision. At the moment,
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our belief is that the probability of no competitor entering is 0:3. If we
believe that our uncertainty about this probability is such that z will
not go below 0:16 (for instance, we believe that x will vary between 0:2
and 0:4), then our decision to develop the new division and is robust
with respect to the variation of x. Conversely, if we believe, for instance
that x is in between 0:1 and 0:5, then our decision is no more robust to
this uncertainty.
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